1. Briefly explain how a good financial sector (banks, financial institutions, etc) would allocate capital efficiently. Give a specific, fictitious example of a bank re-allocating capital from a bad business to a good business.

2. Carefully explain how a weak financial sector prevents an efficient allocation of capital. Again, give an example.

3. What evidence do the authors cite to support a link between the strength of the financial sector and productivity growth (as measured by the growth of TFP)?

4. What role does liquidation play in the "creative destruction" process? That is, how does it lead to a better allocation of capital in the long run?

5. The authors argue that financial institutions should prepare for recessions by building up large "capital buffers" in advance. These capital buffers are like excess reserves of capital. That way, when a recession takes place these financial institutions can liquidate at discount prices without violating capital requirements. What exactly are "capital requirements"? Look up the term then describe what a capital requirement is. HINT: "Capital requirements" are very similar to the "reserve requirements" you are familiar with.

Answer rating: 100% (QA)

Efficient vs Weak Financial Sectors and Capital Allocation 1 Efficient Capital Allocation by a Strong Financial Sector Matching Risk and Return A strong financial sector efficiently allocates capital ... View the full answer